The University of Liverpool

The Management School

Managing Finance (ULMS767)

Essay

Essay TITLE:“Explain what sources of finance are available for small to medium sized companies and explain why they sometimes face difficulties in

raising finance”

Name: KANG QIONGYU

Student Number: 200840845

MSc Major: MSc Consumer Market

Contents

Introduction.................................................................................................................................1

The sources of finance that are available for small to medium sized companies...........1

Internal sources.......................................................................................................................2

External sources......................................................................................................................3

Difficulties for SMEs to raise funds...........................................................................................5

Conclusion..................................................................................................................................7

Reference:...................................................................................................................................8

Explain what sources of finance are available for small to medium sized companies and

explain why they sometimes face difficulties in raising finance

Introduction

This essay focuses on financing alternatives for small to medium sized enterprises(SMEs). This

essay would be separated in to two parts, in the first part, it would discuss about the sources of

finance that are available for small to medium sized enterprises, and in the second part, it would talk

about the reason why the small to medium sized companies face difficulties in raising finance.

There are two types of finance that are available to small to medium sized enterprises, which are

called internal finance and external finance. Small to medium sized enterprises often have difficulty

in signalling their creditworthiness. Unlike large companies, much more Informational asymmetries

between lenders and borrowers and incentive asymmetries between owners and managers are

happen in the case of small to medium sized enterprises. As a consequence, small to medium sized

enterprises are limited in the potential to issue stock, they also tend to be disadvantaged over large

business in terms of access to bank loans. This article would like to analysis these problems from a

theoretical perspective.

The sources of finance that are available for small to medium sized companies

Small and medium enterprises are companies whose headcount or turnover falls below certain

limits. In most economies, there are much more smaller enterprises than large companies. In many

economic sectors, SMEs usually show the ability to drive innovation and competition.

According to recent EBRD research, although they face many problems like economic, institutional

and legal obstacles, small- and medium-sized enterprises (SMEs) are the ones show the ability to

participate in the areas of comparative advantage and high value added, they are considered to

potentially constitute the most dynamic firms in an emerging economy. There are many kinds of

obstacles which include limited access to working capital and long-term credit, inadequate

infrastructure, legal and regulatory restrictions, limited managerial and technical expertise and high

transaction costs. Although there is a support to SMEs from international policies, and other

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problems like the presence of multiple and often interrelated constraints, the widespread belief is

that the lack of finance constitutes would be the main obstacle to the growth of SMEs (Pissarides

1999).

To start and grow new business ventures, financial resources are critical, this is suit for anywhere in

the world. Most of entrepreneurs start and sustain new businesses with their own assets or family

and friends’ savings, they usually depend on tax breaks and other benefits provided by the state and

attract access banks venture capitalists and commercial credits(Gratchev, M, & Bobina, M 2001).

In most countries and particularly in developing countries, finance is still a key limiting factor for

small and medium-sized enterprises(SMEs). Generally speaking, banks are perceived as risky and

unprofitable, so they refuse credit to SMEs. However, SME does not include more risk for the bank

than lending to large enterprises or the public sector, because many research show that SME lending

can be profitable.

The SMEs would turn to one or more methods of payment because of its financial plan and the

analysis of its capacities of financing. In general, they are offered two major possibilities :

Internal financing

External financing

Internal financing

Internal financing is the most important part of all international development, and external financing

which based on it would build an extra benefit. As a matter of fact, most small and medium sized

enterprises must rely on internal financing, and external lenders would be refuse all intervention

without internal financing.

Internal financing consists of :

income from transfers of the assets (debts, grounds, buildings, patents, and so on).

allocations for paying off debts, deposits, and stock ;

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self financing formed by unallocated profits ;

External financing

The companies which assume international activities usually have good methods of financing when

they facing import and export. For instance, in many countries that finance products destined for

export or that do not have easy access to international capital markets, credit can be admitted to

purchasers situated.

External financing consists of :

Bank overdraft

Credit cards

Bank loan/Commercial mortgage

Leasing or hire purchase

Loans/equity from directors

Loans/equity from family and friends

Invoice finance

Grants

Loans from other 3rd parties

Export/import finance

According to the company's needs, it has been separate to three parts, as before delivery, during

storage or after delivery.

1. Financing needs before delivery

Client deposits: The small and medium sized enterprises can ask for deposits from their clients to

reduce their need for financing. If so, the clients have paid part of the products that they have

ordered. When the product or service would take a long time to produce, the companies would like

to use deposits. Usually, their sum only demonstrate a small part of the contract's total value.

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Pre-financing credits : The SMEs should turn towards other financing because that deposits which

should be paid by the foreign purchaser are often insufficient. During the manufacture of products

destined to be exported, prefinancing credits are granted by banks to companies. Consequently, they

enable the products of exports to be financed, by this means, it linked to a very big gap between the

manufacture and invoicing when reducing the financial deficit.

2. Financing of product stocks

Preparing for canvassing for orders oversea, company needs to launch a great amount of stocks of

equipments or asserts. What’s more, some specific needs is also within consideration, such like the

case for certain export markets, specific financing is necessary.

Through tough negotiation artfully, company can finance stocks by getting the payment deadline as

long as possible. However, it does not always work. This prefinancing credits aside, loans in foreign

currency is also available. Hopefully collection credit and warehouse relocation under customs may

work to tight up the budget, by shrinking the fees and taxes this way, cost is expected to be largely

cut down.

3. Financing needs after delivery

Documentary credit: Documentary credit, which means the buyer should get to the buyer's bank to

defray the exporters instead of turning over the documents which will prove that the provision of

service has been performed and the delivery of goods. And than the documents will be sent to the

buyers'bank or by the buyers' bank rather than repayment, at the end, the bank can own the goods.

As a result, when the goods delivered the seller can set out his goods' payments by that way which

has been illustrated above and at the same time the he can get the needed the transport documents

and commercial to the bank of his.

Loans in foreign currency (or advance in foreign currency): Advance in foreign currency,

which handles a short-term financial credit, the one caused by business activities to be covered and

enables the intervals of financing. The firm can get the loan which is the same thing as the amount

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of the invoice, the invoice will be rebuild its earning by the way of selling foreign capital during the

circulate of the invoice, and once the customer paid the invoice the seller can use the client's debt

to repay the loan. There is a advantage of loans in foreign currency, which is the loans can be a way

of fleeing the foreign exchange risks equally.

The reason why the small to medium sized companies face difficulties in raising finance

Basic reasons

At the present time, due to the influence of by internal and external factors, small and medium-sized

enterprises still have the problems in raising finance, their trouble mainly displays in financing

environment, financing structure and financing channels.

1. Financing environment

According to the internal financing environment, the small to medium sized enterprises usually lack

of their own fund, long-run stability of a business, risk resistance capacity, facility of production,

core competitiveness, at the same time, the scarcity of talent person and low-efficiency management

also make the small to medium sized companies have problems in raising finance.

According to the external financing environment, at present time the severe macroeconomic

situation make adverse effect in external financing to small and medium sized enterprises. As the

the deep influence of financial crisis, securities business and money corporation would have

financial strain, it would make many problems to the small and medium sized enterprises in raising

finance.

2. financing structure

The small and medium sized enterprises always rely on their own fund and retained earnings not

only in initial stage of pioneering, but also in the period of expansion. The roportion of internal

financing in SMEs is too high, and they would have have low debt ratio. It would influence the goal

of maximizing the profits of enterprises. This kind of financing structure was not propitious for

further expansion of the company.

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The proportion of direct financing like public stock offering and public issuance of bonds is very

low. It is difficult for the small and medium sized enterprises to fund raising with stock right

financing. The bank usually supply short term credit to the SMEs, but lack of medium-term and

longterm credit.

3. financing channels

According to financing method, the small and medium sized enterprises usually use indirect

financing like bank loan, entrustment loans through bank or non-bank financial, and so on. They

less use direct finance, like share issue and issue debentures. The SMEs almost never use the other

method of financing, like financial leasing, note discount, receivables, risk investment, foundation,

affiance, short-term financing. Based on these reasons, the financing channels for SMEs is limited.

Self reason

Bank loan is still one of principal pathway to gain financial support, many small to medium sized

enterprises are still waiting for the opportunities. Most SMEs cannot fulfil the request for bank

credit due to the problems they have in managing companies, so it would influence the companies

to gain financial support from bank.

1. Lack of mortgage assets

Most small and medium sized enterprises lack of enough mortgage assets and have high asset-

liabilities, other companies would not like to vouch for them, this makes most SMEs cannot

demand for financing from bank. For instance, some high-tech enterprises, like IT companies have

low net assets(NA) and high human capital, but software can not be mortgage assets, so it is hard

for them to get the loan.

2. Lack of standard administration structure

Many small to medium sized enterprises use family-based management mode, this kind of

companies lack of scientific management pattern, when they facing stock financing, there may be

many internal struggle, for these reasons external potential capital dare not participate in the

companies.

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3. Low degrees of comparison

Most small and medium sized enterprises have less chance to build their degrees of comparison

than large companies. Bank usually give large companies long term loan but not SMEs.

4. High operating risk

Small and medium sized enterprises have high failure rate, to invest would have high risk. SMEs

need not much at one time, but they need many times, this kind of method of loan would raise cost

of bank, so bank would not like to invest SMEs.

5. Crude management

Small and medium sized enterprises lack of high quality experienced manager, they usually care

about development and speed but pay less attention to the quality, benefit and manage. As these

reasons, they west a lot of resource.

Conclusion

Finance is one of the most important parts of SMEs to develop themselves, there are many kind of

ways to raise finance, like internal financing and external financing. There are strongly relationship

between internal financing and external financing, and both of them are essential to SMEs. There

are many reasons that make the limit to the development of SMEs, like self reasons and outside

reasons. Not only the outside reasons influence the development of SMEs, but also self reasons play

a important role of the affect to SMEs. Self reasons are also linked to outside reasons, so we should

pay attention to all kinds of reasons which influence SMEs. Facing the present situation, the

managers of SMEs would point out some measure to solve the problems.

Reference

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Almeida, H, & Campello, M 2010, 'Financing Frictions and the Substitution between Internal and External Funds',

Journal Of Financial & Quantitative Analysis, 45, 3, pp. 589-622, Business Source Premier, EBSCOhost, viewed

22 November 2011.

Barnes, M, & Pancost, N 2010, 'Internal Sources of Finance and the Great Recession', Research Review, 14, pp.

29-32, Business Source Premier, EBSCOhost, viewed 22 November 2011.

Gratchev, M, & Bobina, M 2001, 'Financial resources for new business in Russia: desirable vs available', Venture

Capital, 3, 3, pp. 263-274, Business Source Premier, EBSCOhost, viewed 21 November 2011.

Pissarides, F., 1999, Is lack of funds the main obstacle to growth? EBRD’s experience with small- and medium-

sized businesses in Central and Eastern Europe. Journal of Business Venturing, 5-6, 519–539.

SWEENEY, P 2010, 'SMEs Tough Out The ECONOMY', Financial Executive, 26, 8, pp. 44-47, Business Source

Premier, EBSCOhost, viewed 22 November 2011

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